April 4, 2013 / 10:26 AM / 4 years ago

EURO GOVT-Spanish bonds rally after above-target debt sale

* Spain sells more than planned at bond auction

* Investors expect monetary easing signals from the ECB

* Bunds may dip if ECB maintains status quo

By Marius Zaharia

LONDON, April 4 (Reuters) - Spanish bonds rallied on Thursday after Madrid sold more debt than planned at an auction, while German Bunds were steady with investors reluctant to place fresh bets before an ECB meeting.

Spain drew strong demand for its bonds from investors. Analysts said the backstop provided by the European Central Bank's as-yet untested bond-buying programme had offset any worries about a potential fallout from the Cypriot crisis.

Spain was seen especially at risk from contagion from Cyprus due to its fragile banking system. Nicosia's bailout is the first to impose losses on bank depositors and many analysts had feared the move could trigger bank runs across the euro zone.

With no sign that was happening, however, investors jumped on the relatively high-yields on offer in Spain.

Ten-year Spanish yields fell 8 basis points on the day to 4.85 percent, some 357 basis points over equivalent German yields - the euro zone's benchmark.

"The underlying situation has stabilised a bit with the Cyprus crisis getting better," said Gianluca Ziglio, executive director of fixed income research at Sunrise Brokers.

"There is still room for rallying in Spanish bonds, probably they could target 330-340 bps in terms of spreads."

Those levels represented the lower end of this year's roughly 60 bps range for Spanish/German 10-year yield spreads.

ING rate strategist Alessandro Giansanti saw 320 bps as the lower limit, saying an improvement in Spanish budget and growth data was needed for the spread to shrink beyond that level.

Worries about Italy, which is still in search of a government after an election in February resulted in political deadlock, may also cap gains for Spanish bonds, analysts said.

ECB MEETING

With the Spanish auction out of the way, attention shifted towards the ECB meeting.

Analysts say markets are positioned for the ECB to keep its key interest rate unchanged at a record low 0.75 percent but that it potentially offer hints that future monetary policy easing might be on the cards.

The euro zone economic decline continued in March, PMI surveys showed on Thursday, with analysts saying the data was supporting the case for further monetary easing.

Investors will scrutinise any comments ECB President Mario Draghi makes during the post-meeting news conference about his expectations for how the economy will fare later in the year.

"If he still signals that in the second half he expects a small recovery, Bunds will sell off," said Emile Cardon, market economist at Rabobank in Utrecht.

He added, though, that such a reaction may be limited and shortlived given that Bunds are seen as a safe haven and with investors still worried about the potential ramifications of Cypriot's tough bailout and political uncertainty in Italy.

Bund futures were last 2 ticks lower on the day at 145.50, while cash 10-year German yields were flat at 1.28 percent. Cardon said he saw a near-term range of 1.20-1.40 percent for Bund yields, but added they were more likely to fall from current levels than rise.

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